It's time to show the receipts, CEOs.
For more than a year, investors have been pushing up stock prices, even though the pandemic caused profits to crater for companies. With COVID-19 vaccines going into arms and businesses reopening, investors want to see that faith rewarded with some proof of fat profit growth, starting now.
Not only are expectations high for this upcoming earnings season, which got going Wednesday with reports from JPMorgan Chase and other big banks, they're rising even more by the day. When the first quarter began, analysts were forecasting earnings growth of less than 16% for S&P 500 companies. Now, those same analysts say the tally should be closer to 25%.
If companies end up reporting better numbers than analysts predicted — which is what usually happens — this may be the best reporting season for growth in more than a decade, according to FactSet. During the summer of 2010, S&P 500 companies reported 34% growth coming out of the Great Recession.
“The bar has been raised, but not by enough,” Deutsche Bank strategist Binky Chadha said of expectations for this earnings season.
Even the best profit growth in a decade may not juice stock prices further, though, because the S&P 500 has already soared more than 80% since hitting a bottom in March 2020.
Last quarter, for example, companies that reported higher sales and earnings than expected actually lagged the S&P 500 the following day, according to Savita Subramanian, equity strategist at Bank of America.
This earnings season, many analysts expect companies to again get little to no boost for reporting stronger-than-expected earnings, given how much their stocks have already rallied on those expectations.
That's why it's important to remember that a “blowout quarter doesn't mean blowout market,” Subramanian said in a BofA Global Research report.
Analysts and investors are expecting profits to zoom even higher through the summer, with growth forecast to soar above 50% in the third quarter. But several challenges lie ahead that could threaten such lofty targets in coming quarters and years.
Chief among them is the prospect of inflation. As the global economy recovers, prices are rising for oil and many other commodities that companies use to make things. Production problems caused by the pandemic are also causing shortages of semiconductors and other products, ratcheting up prices even higher.
Some companies will be able to pass those higher costs on to their customers, by raising prices at the register. The company behind Huggies diapers and Kleenex tissues said recently that it would raise list prices for most of its North American consumer products, for example. Kimberly-Clark said it needed to raise prices by “mid-to-high single digits” because of the higher prices it was paying for commodities.
But any drop in sales that results from the higher costs, or the inability of companies to pass on higher prices, would squeeze profit margins for companies as the year progresses.
Higher inflation is something that the Federal Reserve actually wants to see, and it has said that it will allow inflation to rise above its 2% target for a while before it tries to tamp down rising prices across the economy.
In the longer term, companies could also face profit pressure from higher tax rates as President Joe Biden pushes for corporate America to help pay for his plan to rejuvenate the nation's infrastructure. If tax hikes pass, the impact on businesses would likely be felt next year.
Strategists at Goldman Sachs say they expect the focus of investors to turn toward such proposals, and away from the threat of inflation and higher interest rates, “as the taxman cometh.”
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